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In this article:

  1. What is a business term loan?
  2. Pros and cons of term loans
  3. 3 ways term loans might be different from what you expected
  4. What you need to get a term loan

Getting your first small business financing can be stressful. The terminology is unfamiliar, there’s a lot of paperwork involved, and you may have nagging questions—is this the right time to be taking out a loan? Is this the best rate I can get? Do I really know what I’m doing?

Thankfully, it doesn’t have to be that hard. With a little education, you can be more confident that you’re making the right decision, and that you have the kind of financing that you need to grow your business.

In this article, we’ll look at one of the most common types of loans—the business term loan—and help you understand how it may be different than you expected, and when and why you should use it.

What is a business term loan?

A business term loan is a loan that provides you with a lump sum of money upfront that you borrow from a lender, then pay back at fixed intervals over a set period of time, with interest. Depending on your lender and the terms of the loan, you’ll pay off the loan on a weekly, bi-weekly, or monthly basis. Repayment periods can last from a few months up to 10 years or more.

Term loans can range in size from $2,000 to $5 million, with APRs starting as low as 6%.

Like personal loans, these loans usually follow an amortization schedule. This means most of your payment goes toward paying interest at the beginning of the loan, and more toward principal near the end. Term loans can sometimes be repaid early, but that may come with a prepayment penalty.

Pros and cons of term loans

Term loans have many benefits that make them a great financing option, but they aren’t right for every situation or every company, so you’ll also want to be aware of the cons.

Some of the pros of term loans include:

  • You can borrow large loan amounts.
  • Long repayment terms can make big investments more affordable.
  • Repaying term loans on time can help you build business credit, which is beneficial for new businesses.
  • If borrowing from online lenders, you can be approved and funded quickly.
  • It can be easier to qualify for a loan from an online lender

Some cons to consider are:

  • Less flexibility than business lines of credit or business credit cards.
  • Loans with a shorter repayment term can sometimes come with high costs.
  • SBA loans are low-cost but come with strict requirements and can take longer to receive.
  • Collateral, like personal assets, or a personal guarantee may be required by some lenders.
  • Some lenders may require an origination fee to process your application.

With any financing option, your business is taking on a certain level of risk. So be sure to weigh the pros and cons (including the interest rates you get) when making your decision about whether or not to take out a term loan.

3 ways term loans might be different from what you expected

The fact that you’re reading this article right now is a sign that you have some awareness of what a term loan is, but maybe you’re not completely comfortable taking out a business loan like this without double-checking your assumptions. Great! You’ve come to the right place. Here are a few ways term loans might surprise you:

1. Term loans can come from several different types of lenders

Business term loans are offered by traditional banks, credit unions, and online lenders.

Banks and credit unions offer low rates on term loans but often have stricter qualification requirements, such as a strong personal and business credit score and high annual revenue. They can also take longer to fund. Typically, bank term loans have long repayment terms of up to 10 years.

Online lenders offer speed and convenience but often have higher costs. However, it is also often easier to qualify for a loan from an online lender than a traditional bank. Additionally, there is more flexibility in repayment terms. You can get short-term loans with repayment terms between three months and three years from online business lenders.

Banks, credit unions, and online lenders all can provide SBA loans, which are backed by the U.S. Small Business Administration. These term loans can provide up to $5 million and come with repayment terms of up to 25 years, depending on what you plan on using the money for. SBA loans have some of the lowest APRs, making them a good option for long-term financing, but have a lengthy loan application process and strict requirements for qualifying. The SBA also backs microloans which can be a great option for nonprofits.

2.  Term loans have different term lengths

The length of your repayment term can have a big impact on whether this type of loan is a good financial decision. You’ll have to find a lender who offers you a term, payment schedule, and interest rate that make sense for your business and financial situation. But unlike home mortgages, where you typically have a 15-year and a 30-year option, business term loans have more variety.

Short-term loans

These loans typically have repayment terms of 12 months or less. Short-term loans are usually offered by online lenders and can offer you funding quickly. Although short-term business loans can be easier to qualify for than some other business term loans, they often have higher interest rates with larger payments required on a daily or weekly basis.

Click here to see how Bilal Bhatti used a short-term loan to fund his franchise expansion.

Medium-term loans

Medium-term loans generally have repayment terms ranging from one to five years. These loans are available from online lenders as well as banks and credit unions.

Compared with short-term loans, there are usually stricter requirements to qualify for a medium-term loan. However, they often also come with more affordable interest rates. Typically, medium-term loans are repaid with weekly or monthly payments.

Long-term loans

Although medium-term loans and long-term loans are sometimes grouped together, long-term typically refers to loans with a repayment period of more than five years.

Long-term loans take longer to get approved for but offer lower interest rates and ideal terms for financing large projects.

These loans are generally repaid on a monthly basis, with lower individual payments spread out over a longer period of time. The total cost of debt, however, may be more overall compared with short-term or medium-term loans.

With terms of up to 25 years, SBA 7(a) loans are a common example of long-term business loans.

3. Term loans have a variety of uses

Traditional term loans can be used for a large variety of different financing needs. While some, like the SBA 7(a) or especially an SBA 504, are limited in scope, in general, you can get a term loan for the following purposes:

Real Estate.

Since real estate is typically a very large purchase, a term loan is frequently needed to make this type of investment. While most term loans and SBA loans, like an SBA 7(a) loan, can be used for real estate purchases, the SBA 504 loan, is especially good for this type of business financing.

The purpose of SBA 504 loans is to encourage job creation and community development, making them perfect for big investments, like buying real estate. These loans typically have low, fixed interest rates, long-term financing, and small down payments.

Facility Repairs or Expansion

Term loans can help you cover the costs of repairing or expanding your facility. Like buying real estate, repairing or expanding your existing facility or storefront is considered a “development” need for businesses, meaning a 504 loan also works well for this type of investment.

Since facility repairs and expansion may not cost as much as buying an entirely new property, you may have more flexibility in the type of term loan you get and the repayment length.

Equipment and Inventory

While you can use a line of credit or business credit card to purchase equipment, term loans may be a better financing option if you’re making a large investment. You can use traditional term loans from a bank or online lender for your equipment loans, or you might even be able to use an SBA 7(a) or SBA 504 loan, depending on your exact needs.

Working Capital

Working capital financing is commonly used to increase cash flow, help meet payroll, pay rent, or make debt payments during a slow season. Startup financing like a business line of credit or a merchant cash advance can be used for this type of financing, but if you don’t need financing as quickly, term loans can still be an excellent option for working capital loans. An SBA 7(a) loan or a more immediate loan from an online lender may be useful here.

Refinancing or Paying Off Debt

If you previously took out a loan that does not have the most favorable terms or need to refinance, taking out a better loan can help you more quickly pay off those old debts. Traditional term loans and SBA 7(a) loans can be used for this.

SBA loans typically have a better rate than traditional term loans, but a traditional term loan will typically be easier to get. Because the federal government is not involved in traditional term loans, the application process should be less complicated.

What you need to get a term loan

While some requirements may vary depending on the loan you apply for and the lender that you use, in general borrowers should be prepared with all of the following documents when applying for any small business loans: 

  • Credit report with your credit history and credit score
  • Records of how long you’ve been in business
  • Bank statements from your personal and business bank accounts
  • Proof of your annual revenue
  • Business financial statements, like your balance sheet
  • Business legal documents
  • Business and personal tax returns
  • Business plan

No matter what lender you’re using or what kind of loan you’re applying for, it’s always better to be overprepared with documentation and financial information than underprepared. Especially when dealing with urgent business matters and a potentially lengthy application process, it’s better to have all of your paperwork in order before you start, so that you don’t waste time by having to start over halfway through the process due to missing information.

Wrapping Up

Term loans, whether traditional term loans or SBA loans, are a reliable source of funding for small business owners. Because they can come from such a wide variety of lenders, offer varying prepayment terms, and can be used for so many different purposes, term loans are still one of the best financing options available. Make sure to explore your options, including reliable online lenders, and prepare your documents ahead of time so that you can quickly and easily get approved for the financing you need with a term loan.

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